UK Deflation Risk - And How To Manage ItMon 23rd March 2015

There is a risk that the UK may be heading for deflation for the first time since 1960. The inflation figures for February will be released on Tuesday and are likely to show that the annual rate of inflation fell from 0.3 per cent to 0.2 per cent, but it may have been as low as 0.1 per cent. During March, energy price cuts, which had already been announced, will be included. British Gas has cut consumer prices by 5 per cent for example. The exceptional weakness of the euro will also have had an impact during March with cheaper imports coming from the continent.

Against this background, will UK interest rates be cut? A few weeks ago, Mark Carney, the Governor of the Bank of England, said that this could be a possibility and the Bank's Chief Economist, Andy Haldane, last week said that the next move in interest rates was as likely to be down as up. The Bank's inflation target is 2 per cent and the Office for Budget Responsibility is now forecasting that inflation in the UK will not get back to that level until 2019. The OBR was forecasting in December that the average rate of inflation for 2015 would be 1.1 per cent in the UK, but it has now reduced that forecast to 0.2 per cent given the possibility of a few months of negative inflation.

There are good reasons to believe that any period of deflation will be short-lived. The first is that oil prices are unlikely to fall much further and the euro seems to have bottomed, which will limit the fall in prices of food and goods imported from Europe. The second is that the consumer has benefited from lower petrol and food prices and the real increase in wages will be the highest for a decade. It is likely that this will lead through to higher levels of consumer expenditure, which should limit deflationary forces. Thus, any decrease in UK interest rates will be for a short time.

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Even if the consumer begins to spend more, it is unlikely that interest rates will rise above the current level of 0.5 per cent for a considerable period of time as whichever party forms the next government will have to implement a fiscal tightening (higher taxes) in order to bring the budget deficit under control. If interest rates and taxes were to rise at the same time, economic growth could be extinguished leading to lower tax receipts.

So, whatever happens, savers are going to have to continue to contend with low interest rates. The search for income will continue and Money&Co. loans are a good source of income. The latest loan on the site is 67 per cent funded with 17 days to go. The current interest rate on the loan is running at 10.2 per cent. This means that the average rate of interest across all the loans that Money&Co. lenders have funded to date is 8.91 per cent. We take a fee of 1 per cent and so that means that the net rate of interest to lenders who have invested in all our loans is running at 7.91 per cent. With inflation close to zero, this looks extremely attractive.

Disclaimer: Money&Co.™ is the trading name of Denmark Square Limited, Company Number 08561817,
registered in England & Wales, authorised and regulated by the Financial Conduct Authority (FCA).
The company is identified on the Financial Services Register under Reference Number 727325.
The registered office is 58 Glentham Road, Barnes, London, SW13 9JJ where the register of Directors may be inspected. Denmark Square Limited (ISA manager reference number Z1932) manages the Money&Co. Innovative Finance ISA.